Ahead of the Curve

The lending environment is undergoing a worrying change. Funds that European direct lenders have raised but not yet deployed are at an all-time high and banks in most Western-European jurisdictions have renewed lending following years of reticence after the global financial crisis, leading to increased competition amongst lenders in the small and medium enterprise (SME) market.

European Equities: UK equities: The Liontrust approach

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The UK equity market is still distinct from that of continental Europe because of factors such as its size, the large number of multi-nationals and mid-sized companies with global presence, and a still large domestic institutional investor base in the form of pension funds with relatively high domestic equity exposures.

Even without large growth in the UK economy that would benefit domestically oriented companies such as housebuilders, the UK's stock of international companies enables specialist UK fund managers such as Anthony Cross and Julian Fosh, who run Liontrust Asset Management's UK Growth portfolios, to search for companies that they believe have a durable economic advantage and a truly global scope to their operations. The UK market does have a number of such companies: Rotork for example, is one of the world's leading manufacturers of industrial valve actuators, control systems, gearboxes and accessories; Halma makes smoke detection and other hazard detection and life protection equipment where demand is highly driven by regulation; Spirax Sarco is a very successful specialist in industrial steam applications.

A fundamental principle of competitive markets is that profits regress to the mean. The Liontrust strategy is to identify companies that can defy this principle to sustain a higher than average level of profitability for longer than expected.

"Warren Buffett described it as castles defended by moats and our style is somewhat akin to Buffett's," explains Cross. "But he had the advantage of being able to invest in US consumer companies such as Coca Cola as they spread out over the world. We are trying to find barriers to competition through intellectual property that is difficult to exploit by competitors but easy to wheel out globally."

The main portfolio has 40-50 stocks and with turnover typically less than 20% a year, and often less than 10%. This low turnover reflects a very long time horizon, which also comes through in some of their preferences in corporate style. "We are not particularly keen on M&A," says Cross. "We prefer management focussing on bolt-on deals rather than life changing ones."

They also like evidence that management have stakes in their companies and for smaller company investments they stipulate that at least 3% of equity should be owned by the directors.

Cross and Fosh observe that, in their experience, strong competitive positions usually revolve around three categories of intangible assets. First, intellectual property such as patents, copyright and know-how - drug companies such as GlaxoSmithKline are good examples here. Second, strong physical or electronic distribution channels: Cross picks out Aggreko, the global leader in the rental of power and temperature control appliances with 100 locations in 29 countries: "In Africa in 2050 more people will be without power than today because of population growth and the fact that a lot of countries have not made sufficient investment in power". And third, significant recurring business: Cross notes how Capita manages to extend its contracts for outsourced administration functions even in times of economic stress.

Investing in a UK equity portfolio may appear narrow in a more globalised world, but as Liontrust has shown, what it can imply, is seeking outstanding global companies within a manageable universe.